Step 4: Conclude that this market should be free from government intervention.

In a recent rebuttal to a Greg Mankiw column on health care policy, John Cochrane displays this argumentation style in near-perfect form. It is a master class in harrumphing conservative prior-stating, delivered in the ancient traditional style. Young grasshoppers, take note.

Mankiw's article was basically a rundown of reasons that health care shouldn't be considered like a normal market. He covers externalities, adverse selection, incomplete information, unusually high idiosyncratic risk, and behavioral factors (overconsumption).

Cochrane makes a guess at the motivation of Mankiw's column:

I suspect I know what happened. It sounded like a good column idea, "I'll just run down the econ 101 list of potential problems with health care and insurance and do my job as an economic educator."

That sounds about right. In fact, that actually was the reason for my similar column in Bloomberg a few months ago. Frankly, I think bringing readers up to speed on Arrow's classic piece on health care is a pretty good idea for a column. Mankiw generally did a better job than I did, although he didn't mention norms, which I think are ultimately the most important piece of the puzzle (more on that later).

Anyway, Cochrane wrote a pretty unfair and over-the-top response to that Bloomberg post of mine, which also made a rather unintelligent pun using my first name (there's an extra syllable in there, dude!). His response to Mankiw has more meat to it and less dudgeon, but is still rather ascerbic. Cochrane writes:

I am surprised that Greg, usually a good free marketer, would stoop to the noblesse oblige, the cute little peasants are too dumb to know what's good for them argument...

[I]s this a case of two year old with hammer?...

I suspect I know what happened. It sounded like a good column idea, "I'll just run down the econ 101 list of potential problems with health care and insurance and do my job as an economic educator." If so, Greg failed his job of public intellectual...

The last section of After the ACA goes through all these arguments and more, and is better written. I hope blog regulars will forgive the self-promotion, but if Greg hasn't read it, perhaps some of you haven't read it either.

Grumpy indeed!

So, Cochrane's post consists of him hand-waving away the notion that externalities, high idiosyncratic risk, and adverse selection might matter enough in health care markets to justify large-scale government intervention.

To summarize Cochrane's points about externalities:

Health externalities affect only a small subset of the things that Obamacare deals with.

The government forces insurers not to charge people different prices based on their health status.

Other insurance markets, like car insurance, function without breaking down due to adverse selection.

Services to mitigate adverse selection exist in other insurance markets.

Most health expenses are predictable, and thus not subject to adverse selection.

So, to rebut these, I could go through each point one by one and do counter-hand-waving. For example:

The idea that doctors know more about your health than you do assumes that you've already bought health care and are already receiving examinations. Prior to buying, you know your health better.

People can be irrational in some ways (or in some situations) and rational in others, obviously.

The fact that the government forces insurers to pay the same price is part of the policy that's intended to mitigate adverse selection, and therefore can't be used as proof that adverse selection doesn't exist in the absence of government intervention.

Markets might have different amounts of adverse selection. For example, insurers might be able to tell that I'm a bad driver, but not that I just found a potentially cancerous lump in my testicle.

Adverse selection mitigation services are socially costly, and Carmax for health care might work much worse than Carmax for cars.

...and so on.

But who would be right? It really comes down to your priors. Priors about how irrational people are. Priors about how much asymmetric information exists and how much it matters in various markets, Priors about how costly and feasible Carmax for health care would be. Priors about how reputational effects work in health care markets. Priors about how efficient government is at fixing market failures. And so on. Priors, priors, priors.

Instead, here is a novel idea: We could look at the evidence. Instead of thinking a priori about how important we think adverse selection is in health care markets, we could think "Hey, some smart and careful economist or ten has probably done serious, careful empirical work on this topic!" And then we could fire up Google Scholar and look for papers, or perhaps go ask a friend who works in applied microeconomics or the economics of health care.

In his health care article, "After the ACA", Cochrane cites a wide variety of sources, including New Yorker and Wall Street Journal and New York Times and Washington Post articles, a JAMA article and a NEJM, some law articles, a number of blog posts, a JEP article and a JEL article, some conservative think tank reports, Akerlof's "Market for Lemons" article, the comments section of his own blog, and a YouTube video entitled "If Air Travel Worked Like Health Care". (This last one is particularly funny, given that Cochrane excoriated me for claiming that he compared the health insurance industry to the food industry. As if he would ever imply such a thing!)

As silly as a couple of these sources may be, overall this is a fine list - it's good to cite and to have read a breadth of sources, especially on an issue as complex and multifaceted as health care. I certainly cannot claim to have read anywhere nearly as deeply on the subject.

But as far as I can see, Cochrane does not engage with the empirical literature on adverse selection in health insurance markets. He may have read it, but he does not cite it or engage with it in this blog post, or in his his "After the ACA" piece, or anywhere I can find.

This is a shame, because when he bothers to read the literature, Cochrane is quite formidable. When he engaged with Robert Shiller's evidence on excess volatility in financial markets, and when he engaged with New Keynesian theory, Cochrane taught us new and interesting things about both of these issues. In both of these cases, Cochrane approached the issue from a perspective of free-market orthodoxy, and advanced the free-market (or efficient-market) case like a lawyer. But in both cases, he did so in a brilliant way that respected his opponents' arguments and evidence, and ultimately yielded new insight.

But in the case of adverse selection in health insurance, Cochrane does not engage with the literature. And although I haven't read much of that literature, I know it exists, because I've read this 2000 literature review by David Cutler and Richard Zeckhauser. Starting on page 606, Cutler and Zeckhauser first present the basic theory of adverse selection, and then proceed to discuss a large number of studies that use a large and diverse array of techniques to measure the presence of adverse selection in health insurance. They write:

Most empirical work on adverse selection involves data from employers who allow choices of different health insurance plans of varying generosity; a minority of studies look at the Medicare market, where choices are also given. Within these contexts, adverse selection can be quantified in a variety of fashions. Some authors report the difference in premiums or claims generated by adverse selection after controlling for other relevant factors [for example, Price and Mays (1985). Brown at al. (1993)]. Other papers examine the likelihood of enrollment in a generous plan conditional on expected health status [for example, Cutler and Reber (1998)]. A third group measure the predominance of known risk factors among enrollees of more generous health plans compared to those in less generous plans [for example, Ellis (1989)].

Regardless of the exact measurement strategy, however, the data nearly uniformly suggest that adverse selection is quantitatively large. Adverse selection is present in the choice between fee-for-service and managed care plans (8 out of 12 studies, with 2 findings of favorable selection and 3 studies ambiguous), in the choice between being insured and being uninsured (3 out of 4 studies, with 1 ambiguous finding), and in the choice between high-option and low-option plans within a given type (14 out of 14 studies).

They proceed to list the studies in a table, along with brief summaries of the methods and the results.

Have I read any of these studies? In fact, I have read only one of them - a 1998 study of some government and university employees, also by Cutler and Zeckhauser. They document a market breakdown - the disappearance of high-coverage health plans. And they present evidence that this breakdown was due to the so-called "adverse selection death spiral", in which healthy people leave high-coverage plans until the plans can no longer be offered. And they show that a similar thing was starting to happen to the Group Insurance Commission of Massachussetts, before major reforms were made to the system that prevented the death spiral.

So there is some evidence that adverse selection not only exists and creates costs in (at least some!) health insurance markets, but is so severe that it can cause market breakdown of the classic Akerlofian type.

If I were setting out to dismiss the possibility of this sort of major adverse selection, I would read a number of these papers, or at least skim their results. I would also look for more recent work on the subject.

I would also read the literature on adverse selection in other insurance markets, to see whether there's a noticeable difference between types of insurance. I'd read this Chiappori and Salanie paper on auto insurance, for example (which I had to study in grad school), which finds no evidence of adverse selection in car insurance. That would make me think "Hmm, maybe car insurance and health insurance are two very different markets."

I am not setting out to dismiss adverse selection, however. Nor am I setting out to claim that it's a big enough problem that it requires major government regulation of the health insurance market. Nor am I claiming that Obamacare passes a cost-benefit test as a remedy for adverse selection. In fact, I don't even think that adverse selection is the main reason we regulate health care! I think it's kind of a sideshow - an annoyance that we have to deal with, but not the central issue. I think the central issue of health care regulation is just a social norm - the widespread belief that everyone ought to have health care, and that the cost of health care ought to depend only on your ability to pay. Those norms, I believe, are why people embrace universal health care, and why they are now coming to embrace the radical solution of single-payer health care.

But that's just me. Cochrane thinks adverse selection is the big issue, so he goes after it, but without standing on the shoulders of the giants who have investigated the matter before. Instead, he waves the problem away. Unlike me, who am but a lowly journalist, Cochrane is a celebrated professional economist. He has done much better in the past, and he could do better now if he chose.

17 comments:

I agree with everything you say here, but doesn't it equally apply to progressives?

For example, whenever I read articles by progressives giving the economic case for government intervention in healthcare markets, they inevitably at some point bring up adverse selection. They never do a literature review. Nor do I think they spent any time reading it. They just heard about this concept and decided to throw it into the argument to make it more powerful.

Everyone does what Cochrane is doing when discussing policy topics of which they have little expertise.

If someone says "We know adverse selection is a problem therefore we need to do X", then you better cite some evidence, yeah. If you just say "Adverse selection could be an issue here so we need to think about it", then fine.

I just want to point out that you and Cochrane are arguing about two different sides of adverse selection. If we force insurers to charge the same rate then insurance companies will be selected against, leading to the death spiral everyone is talking about. On the other hand, the pre-ACA market had a lot of adverse selection against patients (high cost patients would be charged astronomical rates for insurance). I feel like your arguments are passing like ships in the night. Information assymetry in health insurance happens whether we have ACA or not, but the assymetry favors different groups in different scenarios.

Forcing insurers to charge the same rate only leads to adverse selection if there is not also the requirement to carry insurance.

This is why the ACA uses a "three legged stool" system of community rating, mandated coverage, and subsidies.

Of course you can argue that community rating to force insurers to charge the same rate would lead to a death spiral is true in the abstract. But that's not a relevant argument as to why government intervention in healthcare markets is bad. At best, it's an argument that bad intervention is bad.

I don't know why you complain about Cochrane failing to engage with empirical evidence regarding questions relating to how to best provide health care in a society.

His positions aren't based on evidence. It's entirely a matter of ideology and morality. The "free market" to him isn't just the "best" way to decide who gets what. It's the only "moral" way to decide for people like Cochrane.

His prior aren't about how irrational people are and things like that (well, he might have those too). His foundational priors are about the morality of him having to pay in any way, whether through direct taxation or through being put in a pool with those sicker then he and then paying the same price for an insurance plan.

At its core his argument is the same as the "taxes are theft" argument. Society shouldn't force him to give something to someone else.

This back and forth about markets and rationality and externalities and what have you will never solve anything or change anyone's mind. If one believes the market is the only moral way to distribute a resource then empirical evidence about functional problems with using markets for a particular good isn't really addressing the actual reason why Cochrane advocates for health care to be distributed according to how "the market" sees fit.

Noah, you have missed one of the best pieces of empirical work on adverse selection in health markets (and on adverse selection in general). This beast by Nathaniel Hendren (below) identifies the existence of actual missing markets and tie it to the private information held by health care consumers. Hope you see this one.

Indeed. This paper is very nice (from perspective of the importance of the issue, the theory, new data, and new empirical methods). Moreover, I know for a fact that Cochrane is aware of this paper as I have discussed it with him at length (in person and in the comments of his blog) some time ago. Yet he never mentions it and his rebuttal was effectively "I don't really find it convincing". So we know that he is purposefully ignoring the cutting edge of economic research on this subject because it clashes with some combination of his priors and agenda.

As a talented mathematically-oriented economist John Cochrane is very skillful at theorem proving. He is quite deft at marshaling argument from his chosen axioms to well-reasoned conclusions.

But his theorems are only as sound as their axiomatic basis (Noah's priors) and it is here where his economic arguments falter again and again and again.

For reasonable people differ widely in their values, precepts, priors, and morals. In other words, we hold different axioms dear, and Cochrane simply does NOT get to select them for the rest of us. Seemingly, he fails to grasp this.

Stated even more plainly, as I see it, in his public arguments Cochrane frequently succumbs to "mathiness".

I also believe he vehemently and angrily rejects this criticism. It makes him furious.

I have some personal experience in this area. Responding to one of his recent blog essays I submitted a reply--polite but also bluntly critical, and perhaps with a touch of polemical bite (I used the K word)--and he refused to post it as a comment. Again I asked him politely to post my comment and again he refused. (Here I will ignore the irony for libertarianism that his refusal exposes.)

I've been asking the question: is John Cochrane, economist and public commentator, making fundamental blunders of logic and reason?

On its face the question seems highly impertinent. After all, Cochrane has a very distinguished record of academic achievement.

I could restate the question: do world-class experts in any field ever make elementary blunders? Yes, I'd argue.

Here's a point of evidence. The arena of competitive chess is about as open to observation and data gathering as one could imagine. Tournament games are recorded and the results: win, lose or draw, are never in dispute. The outcomes are on the table.

It seems inconceivable that top flight chess grandmasters could ever make basic beginner mistakes. Isn't that part of what makes a grandmaster? The average player will lose to a grandmaster over the board virtually 100 per cent of the time.

Yet the evidence here is incontrovertible: even grandmasters sometimes make horrendous, game losing, beginner-type blunders.

The point: blunders happen even among top flight experts. In chess, the evidence is so clear that there can be no argument: the losing player laughs and moves on. In economics, however, a blunder exposed often provokes protracted outrage by the perpetrator directed at the reporter. Cochrane often rails against his critics, sometimes for years.

I also ask: what makes economics special in this regard? Why are top economists so thin skinned when it comes to accounting for their basic blunders?

There really is no reason to speculate on this. We KNOW what health care was before the ACA. We KNOW what health care has become since the ACA. The Republicans want to go back to the state of affairs before the ACA. The Democrats want to stay with the ACA. No one is truly interested in a more improved system (except Bernie Sanders).

We also know how healthcare is working in the rest of the industrialized world. There is plenty of data which can tell us how things actually work. We don't need to speculate or rely on old (Arrow) or ancient (Herbert Spenser) economic theories.

The question is not as much a technical problem as it is a moral question. Is it acceptable to allow 40,000 people to die every year because they lack health care? We started two wars and spent hundreds of billions of dollars after 9/11 and the death of 2500 Americans, but seem to be indifferent to the deaths of tens of thousands and the suffering of millions of American when it comes to healthcare.

What turns the Republican position into a moral outrage is the fact these deaths and sufferings are completely avoidable. There is no need for anyone to die for a lack of access to healthcare.

In fact, Trumpcare will cost us an additional $200 billion over the next decade -- only to increase health insurance premiums, deny coverage, and close down rural hospitals. This type of thinking is comparable to that which lead to the Late Victorian Holocaust.

John Cochrane criticizes Greg Mankiw for not informing his readers how much of the ACA attempts to fix these hard economic problems. "Greg does not say that the ACA, or even 5% of the ACA, is a necessary solution to these problems."

Noah Smith criticizes Cochrane for not informing his readers of how extensive the hard economic problems are. "Cochrane does not engage with the empirical literature."

Noah (2nd to last paragraph) and Cochrane (3rd to last paragraph) agree that the ACA has little to do with hard economic problems. From Mankiw's article, it is straightforward to infer that he thinks hard economic problems make health care policy hard.

It is also straightforward to no longer draw this conclusion after Mankiw confirms Cochrane's speculation:http://gregmankiw.blogspot.com/2017/09/more-on-economics-of-healtcare.html"It sounded like a good column idea, "I'll just run down the econ 101 list of potential problems with health care and insurance and do my job as an economic educator." "